Chapter 6 Critique Of Maximising Behaviours Of Consumer And Producer Flashcards
Rational Choice theory
States that individuals use logical and sensible reasons to determine the right choice associated with an individual’s best self interest
What is rational consumer choice
The decision making process based on people making choices that result in optimal/maximum level of utility for an individual. Expected to provide the greatest benefit given the choices available.
Examples of Rational choice theory:
Firms aim to be profit maximisers
consumers aim to maximise utility.
consumers buy more of a product if price falls, law of demand
firms buy products from supplier that offers lowest (best) price
shareholders buy stocks with greatest expected rates of return
investors aim to minimize their level of risk
people are happier if they have a higher standard of living.
government wants to improve the economic and social well-being of citizens
However behaviour economics also questions whether we always act rationally and whether all firms im to maximise their profits.
What are the three key assumptions derived from traditional economic theories?
Consumer rationality
Utility maximization
perfect information
What does the concept of consumer rationality mean?
Assumed that individuals use rational calculations/considerations to make sensible choices that align with their own best interests. Driven by self-interest and incentives
What does the concept of utility maximization mean?
Preferences of individuals are described by the level of utility gained from decision. Economic theory assumes people decide on the option that gives them maximum level of utility.
What does the concept of perfect information mean?
Equal access of information about alternatives available. E agents need easy access to perfect information for rational choices. Assumes people use all available knowledge to make a decision.
Too many choices can make people less likely to make a rational decision and can be both physically and mentally exhausting.
What is behavioural economics?
The study of actual economic decision making, emphasis on human behaviour being less rational than traditional economic theory suggests.
What are the limitations of the assumptions of rational consumer choice?
Biases
bounded rationality
bounded self control
bounded selfishness
imperfect information
How is bias limiting assumptions of rational consumer choice?
Cognitive responses are influenced by biases. influence how people process complex information during decision making.
- makes it extremely difficult to make a pure and instantaneous rational decision.
How can biased be categorized
Bias can be categorized as rule of thumb, anchoring+framing, and availability.
Explain the term Rule of Thumb in the context of bias.
Refers to the practical and approximate way of doing something without being exact. judging a situation based on experience affecting choices in trying to meet economic objectives. As a rule of thumb, people tend to stick to a default choice, can lead to irrational decisions
e.g it is normal to assume discounted prices are cheaper than the average price of the same product over a period of time, however this is not often the case.
Explain the terms Anchoring in the context of bias.
Anchoring is a cognitive bias that influences how people view a product by comparing it to something else.
What is an example of anchoring?
Example what we first see when walking in a store becomes an ‘anchor’ which future choices are assessed, such as a discount offer Anything without the discount seems less attractive, but helps convince individuals they are getting a bargain. Without this anchor, some consumers may not have even walked into the store. Real estate agents use anchors by showing offer prices for houses, acting as an anchor for potential home buyers.
What is framing?
Framing is presenting the information to highlight pos/neg aspects that it creates bias in favour of a particular choice. influencing their relative attractiveness to decision makers.
two products, 80% lean vs 20% fat.
Explain the term Availability bias in the context of bias.
refers to the ease with which an idea or event
can be recalled from memory. This causes
people to overestimate the likelihood or probability of the event
or idea ever happening, thereby distorting rational decision-making
What is bounded rationality theory?
states that rationality is limited. This means that people’s cognitive decision- making capacity is limited owing to barriers such as
information failure or the time available to make the decision.
What is bounded self control?
is a limitation of the assumptions of rational consumer, as people may lack the self-control to think for themselves and to make a rational choice. Instead, they conform to social norms and group preferences and pressures, which may not match their own preferences.
What is bounded Selfishness?
means that people are not necessarily selfish and only act in
self-interest, but often behave reciprocally and altruistically. People do not always pursue their own pure self-interest
e,g donating to charity
What is imperfect information?
occurs when people have inaccurate, incomplete or unreliable information, so decision-making is not optimal. Buyers with their asymmetric information can potentially make ‘wrong’ choices. This creates bounded rationality.
How are decisions truly made?
Instinctively/unconsciously rather than logically/consciously, do not weigh up costs+benefits of particular decision
Given people are not necessarily rational, choice architects and nudges are used to overcome pitfalls to reasonable and rational decision making. Applies to consumers making purchasing decisions or employees meeting performance targets. .
What is choice architecture?
The deliberate design of presenting choices in different ways to members of society, and the impact of these methods on decision making. People have limited attention span due to ever growing complexities, so prefer simplicity. Changing context in which people make choices can help create new and desired social/economic behaviour. Simplifying choices makes process of choosing easier.
examples of choice architecture
e.g layout of supermarkets, calorie counts etc.
e.g ‘most popular’ items, ‘top pick’ etc to reduce choice overload.
e.g menus creating nudges for customers to choose items, such as an item beign priced significantly more expensive. But 2nd/3rd most expensive seem like a bargain when customers compare relative prices.
e.g fresh fruits and veggies at entrance of retail stores, placed at eye level as a nudge to encourage+facilitiate consumer choice.
Default choices, restricted choices, mandated choices
What is a choice architect?
Individual/organization responsible for shaping context in which people make decisions, by simplifying the design of different options being presented. Help with choice overload.
Examples of choice architects:
Parents
teachers
colleagues
friends
employers
media
government
Why are choice architects and nudges used?
Due to contradiction between rational human behaviour, and irrational decision making (theory vs reality).
What are perception nudges?
Used by choice architects in response to people reacting differently to same information depending on how it is presented (perception part).
99% fat free vs 1% fat etc.
What is a default choice?
The given decision of an economic agent if no action is taken. These are done to minimize the costs of choosing+deciding what to do. People are more likely to participate when they are automatically enrolled into a scheme, especially as this is the simplest or easiest option.
Examples of default choice:
Being automatically signed up into a system, parents automatically registered to contribute to parent teacher association at school.
side options, such as salads/fries.
What are restricted choices?
Type of choice architecture that limits choices available to people, placing healthier food items on a menu, restricting choice of unhealthier foods. Choice for consumers is restricted, but it is still there. Nudge is created to encourage consumers to opt for the less Unhealthy item. Restricting choices helps make rational/sensible decision.
What does the graph shown represent? (Satisficing vs Profit maximizing)
With reference to the graph, the following applies to the profit-maximizing firm:
- Output = 10,000 units as this is the output level where MC = MR
- Price (or average revenue) = $110
- Average cost = $70
- Hence, the profit for the firm = TR – TC = ($110 × 10,000) – ($70 × 10,000) = $400,000.
By contrast, the profit satisficing firm can charge a price between $90 (the free market equilibrium
price) and $110 (the profit-maximizing price). Suppose the profit-satisficing firm chose to charge $90:
- Price = $90
- Average cost = $70
- Output = 13,000 units
- Hence, the profit for the firm = TR – TC = ($90 × 13,000) – ($70 × 13,000) = $260,000.
profit sacrificing firm settles for lower acceptable level of profit, by charging a lower price and supplying a larger quantity.
